Monday, December 19, 2016

44 Years of Dividend Growth - Canadian Utilities Limited

Since I have been struggling to find ideas for posts lately, I decided to dig deeper on individual companies on the Canadian Dividend All-Star list, the best source to identify quality Canadian companies with at least a five year history of growing their dividends. Since most dividend bloggers overwhelm me with their financial analysis, my plan is to take it light on the numbers while focusing on the qualitative factors that might make the company an attractive or unattractive addition to your investment portfolio. Being a logical thinker, I will start at the top of the Canadian Dividend All-Star list, with Canadian Utilities Limited, the owner of the longest annual streak of dividend raises at 44 years.

Company Overview

A subsidiary of ATCO Ltd., Canadian Utilities' operations consist of their electricity segment (~55% of total revenues) and their pipelines and liquids segment (~45% of total revenue). Both segments include regulated and non-regulated businesses. Although the company's assets and operations are mostly centered in the Canadian province of Alberta, there is growing geographical diversification with investments in Australia and Mexico internationally, and Yukon, the Northwest Territories, and Saskatchewan in Canada.

Dividends

After announcing a 10.2% dividend increase in October 2016, the company's dividend yield is currently ~3.5%. The earnings payout ratio is high at 87% of the trailing 12 months EPS.  The 3, 5, and 10 year dividend growth rates are impressive at 10.1%, 9.3%, and 7.9% respectively.

Valuation

A recent rally in Canadian Utilities' share price has lead to a trailing P/E of 24X. This value is relatively high given the stock has traded in the 18-22X range for most of the past 5 years. Looking at EV/EBITA leads to a similar conclusion, with the company currently trading at 13.5X in contrast with their 5-year average in the 9-12X range.

Qualitative Catalysts

There are some obvious reasons why you would consider adding Canadian Utilities to your investment portfolio

1. Stable Cashflows from Regulated Businesses
- Reviewing the last 5-years of Canadian Utilities financial statements shows that the company benefits from the regulated nature of some of their business segments. There are no wild swings in revenue or profitability that tends to keep investors awake at nights.
2. The Dividend Streak
- As a dividend investor, you should seek out companies with management who is not only committed to sharing their profits with you, but who realize the importance of raising their payouts over time in-line with business results. With the longest annual streak of dividend increases of any Canadian company, the pressure is on Canadian Utilities' management to keep the streak alive.
3. Capital Investments to Grow Earnings
- Canadian Utilities plans to invest $1.5B in growth projects in 2016, $2.8B in 2017, and $1.8B in 2018. Given the company's net profit margin of 11% and ROA of 3% in 2015, the success of these capital projects should enable management to continue to deliver higher dividends to their shareholders.

Qualitative Drawbacks

Beyond the fact that the current valuation of the company's shares seems steep, and that the payout ratio is high even for a utility company, there are some additional drawbacks for investors to consider before adding Canadian Utilities to their investment portfolio.

1. Financing Needed for CAPEX
- With Canadian Utilities aggressive capital expenditure program over the next 3 years, the company will need to continue to access the debt and capital markets. This financing will result in higher leverage and shareholder dilution. In order to fund their $1.5B of CAPEX in 2015, the company issued $650M of additional debt, issued preferred shares of $375M, and used some of their of CFO to make up the difference.
2. High Exposure to Alberta Economy / Oil Prices
- Although I couldn't find exactly how much of the company's revenues and earnings relate to Alberta, I feel very comfortable indicating that the company's results are heavily dependent on the strength of the Alberta economy. Given Alberta's economy tends to move in sequence with the price of oil, it's not a stretch to speak of the high correlation between Canadian Utilities' results and the price of oil.
3. Regulatory Risk
- Being involved in regulated businesses entails the risk that future regulatory decisions outside of the company's control could materially impact Canadian Utilities' operations and results. For instance, the Alberta government would be politically ignorant to allow the company to increase their electricity rates by double digits during a difficult period in the province. At the federal level, as the Canadian government pushes programs to decrease carbon emissions, Canadian Utilities will need to adapt in order to remain compliant and relevant.

Conclusions

Most Canadian dividend growth investors have at least one utility in their investment portfolio. Although it might be tempting to include Canadian Utilities in your portfolio due to their 44 year streak of raising their dividend and the recent 10.2% dividend increase, I would caution that there will likely be a better time to add the company to your holdings. Given the relatively high current valuation, 87% payout ratio, and aggressive capital program over the next 3 years, there are better candidates to buy at the moment.


What would make you consider adding shares of Canadian Utilities to your portfolio?




3 comments: